THE ADVENT OE THE INTERNATIONAL

EINANCIAL REPORTING STANDARDS: A

CATALYST EOR CHANGING GLOBAL
EINANCE
Julia Kotlyar

e are now living through a transformational period marked by a fading

American empire and an emerging global landscape. Recent years have seen
globalization gain breadth and depth as the internet has leveled the playing field,
more countries are producing and selling goods, and capital moves more freely.
Despite twenty years of a very expensive dollar, U,S, exports have held their ground,
and the World Economic Forum currently ranks the United States' $14 trillion
economy as the world's most competitive,' Yet three years ago, the United States
received a loud wake-up call in terms of its position as the nucleus of global finance.
In 2005, twenty-four of the world's twenty-five largest initial public offerings (IPOs)
were floated on exchanges outside the United States,2 In a parallel development, the
twelve non-U,S, sovereign wealth funds (SWFs) established then have grown to
control roughly US$2,5 trillion,3 These upheavals coincided with the introduction
of a new principles-based uniform system of accounting standards in the European
Union (EU), lcnown as International Financial Reporting Standards (IFRS), These
guidelines have since been adopted by more than 100 countries,4 In response to
these changes and to the recent market turmoil, the United States moved in August
2008 to adopt IFRS, conceding that it could no longer function in the global
economy by prescribing American rules for other countries to follow,^ The adoption
of IFRS not only makes the United States more competitive in the world economy,
it also provides a catalyst for change in the world's regulatory and legal frameworks
utilized by all global market participants.
On 27 August 2008, the Securities and Exchange Commission (SEC), America's
financial markets watchdog, made the landmark decision to adopt IFRS in an effort
to promote the sharing of financial information across geographical boundaries by
standardizing terminology. The Commission allowed large American-based multinationals to begin using IFRS for their annual reports as early as 2009 and expects that
most firms will voluntary switch to the standards by 2010,6 A road map for their
Journal of International Affairs, Fall/Winter 2008, Vol, 62, No, 1,
The Trustees of Columbia University in the City of New York

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Julia Kotlyar

mandatory adoption by 2016 has also been proposed/ This last measure was the
latest in a string of proposals under the leadership of SEC Chairman Christopher
Cox designed to bring American and foreign markets closer together. Announcing
the decision, he hailed the new standards as a move to an "international language of
disclosure, transparency and comparability," saying that the proposed road map
marks a cautious step forward from the previously dominant U,S, standards,8
Despite the success of the new standards in integrating regional and global
markets, reducing compliance costs by eliminating the need for reconciliation and
lowering the cost of capital, IFRS only established their first real foothold in the
United States in late 2007, On 15 November, the SEC announced it would allow
foreign companies access to U,S, capital markets while reporting under IFRS,^ That
unanimous vote instantly affected roughly 1,100 companies with U,S, listings, along
with any companies planning U,S, IPOs,'0 At the same time, the SEC started
contemplating changes that would grant domestic firms the choice between reporting under IFRS or the previous set of accounting rulesknown as the Cenerally
Accepted Accounting Principles (CAAP), There were a number of considerations in
favor of embracing IFRS, If the new accounting regime forced firms to be more forthcoming in what and how they report, investors would be better off. The lower costs
and universality of IFRS also promised greater market access for foreign businesses.
Until the November move by the SEC, if a European company wanted to list on the
New York Stock Exchange (NYSE) or any other U,S, exchange, it had to engage in
a costly reconciliation between its IFRS-compliant financial records and the results
under GAAP, 11
THE BUILDUP TO

IFRS

The adoption of IFRS was the United States' answer to a leveling of the playing
field it had once defined and an attempt to counterbalance the negative externalities of competition with emerging countries. Despite the size and dominant position
of U,S, financial stock and capital markets, other regions are growing much more
quickly due to the influx of capital from countries and companies with more investment options. While U,S, GDP accounted for approximately 20 percent of global
output in 2007, it is sure to decline over time given that its investment climate is no
longer as optimal as it once was, 12 Throughout the past few decades, the United
States has had the lowest corporate tax rates of the major industrialized countries, i3
Today, it has the second highest rate after Japan, i4 Higher corporate taxes combined
with stricter regulations about internal controls, such as the post-Enron laws like
Sarbanes-Oxley (SOX), are causing more expensive compliance and inhibiting businesses from investing in the already saturated U,S, market. The additional financial
burden of reconciling foreign flnancial statements or IFRS to GAAP would only add
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The Advent of the International Financial Reporting Standards

to the unfavorable investment climate.
While much of the discussion of the loss of the United States' future market
competitiveness has focused on American regulations, particularly SOX, and the
constant threat of corporate litigation, these obstacles are only part of the reasons
why business has shifted abroad. The United States was blind to the mounting
corporate corruption in the lead-up to SOX and overreacted in its aftermath with
compliance requirements that were too expensive and complex. It is unfortunate
that corporate scandals were the catalyst for revealing the importance of transparency, accuracy, controls and security for investors. The scandals only triggered a
sense of urgency for regulators caused by the widespread fear of losing public confldence. Instead of motivating the regulators to propose forward-thinldng flexible and
transparent regulation, the scandals led them to strengthen internal controls,
American adoption of IFRS has raised questions on both sides of the Atlantic,
On one hand, critics of IFRS in the United States worry that America will lose
control over its flnancial reporting and disclosures to foreign regulators, European
critics are concerned about SEC interference with IFRS standard-setting, which they
fear could cause the resulting principles to be too narrow and prescriptive,i5 Because
IFRS standards are supposed to be endorsed without modiflcation, any disagreement
between foreign and domestic policymakers could come with burdensome legal ramiflcations. Many legal experts, regulators and policymakers are also concerned about
equality of representation among standards-setters, noting that America is underrepresented on the International Accounting Standards Board (IASB), given that the
size of America's equity markets represent almost half of global market capitalization,'6 Instead of debating the control of the standards, however, the United States
should take a leadership role in setting them and establishing dispute settlement
mechanisms, such as those that exist within the World Trade Organization (WTO),
By becoming a proactive stakeholder in the formation of these guidelines, U,S, regulators will ensure the standards do not contradict the core of GAAP,
A GLOBAL ACCOUNTING REVOLUTION
The combination of a more difflcult U,S, investment climate with an increased
number of stakeholders in global flnancial markets^thanks in part to emerging
market economiesstimulated the creation of IFRS, as a means of providing comparability between investment opportunities in different countries and to draw
companies from U,S, exchanges to launch their IPOs, London now competes with
New York as the world's financial center and has already surpassed it in terms of
number of IPOs it hosts,''' Yet, the United States has not only been competing with
the rise of Europe in the global economy, but also with the rise of the rest of the
world. During 2006 and 2007 alone, 124 countries grew at a rate of 4 percent or

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Julia Kotlyar

more, including more than 30 countries in Africa.'

Over thirty years ago, experts were already thinldng about the advantages of
establishing a sole body of accounting rules that could be applied worldwide. In
1973, the International Accounting Standards Committee Foundation (lASC) was
formed to address this issue. In 2001, the International Accounting Standards
Boarda London-based, independent, privately funded organizationthat IASC
encompassed was given the task of drafting international accounting standards to
regain investor confidence and provide a strong investment climate.'^
The first major boost to the new standards came with the European Union's
(EU) decision to adopt IFRS, bringing in nearly one-third of the world economy at
once.20 Under its Financial Services Action Plan, the EU planned to open up a
single market for financial services, maldng a universal and flexible accounting
system indispensable.2i The EU decision provided momentum toward a single standard throughout the world by promoting a domino effect within other countries. To
date, it has become a global phenomenon with approximately 12,000 companies in
more than 100 countries requiring the use of IFRS.22
Like the European Union and United States, China is also adopting IFRS.
However, rather than use the standards published by L\SB, it has interpreted its own
national interpretation of the IFRS called the Accounting Standards for Business
Enterprises, which was issued by the Ministry of Finance in February 2006.23 With
the growth of countries in Asia, competition is increasing from domestic, international, traditional and non-traditional players to enter the Chinese market. This
wave of new entrants into China's financial markets is heightening the competition.
With China's accession to the WTO in December 2001, business activities with and
within China have expanded further as the lifting of geographical and customer
restrictions on foreign companies further promote China's integration with the rest
of the world.24 This increased internationalization and privatization of China's
financial system has also focused the attention of institutions and regulators on
performance and risk management. By increasing transparency of nancial reporting and harmonizing Chinese national accounting standards with IFRS, the
measures adopted in 2006 help enterprises reduce the costs of raising capital and
alleviate the risks of financial crisis.25

A FIRM'S TRANSITION TO IFRS BECOMING A CATALYST FOR

GLOBAL CHANGE
Because the accounting framework of IFRS is largely subjective, the rules-based
American system will need to evolve if the new standard is to succeed in the United
States.26As two of the world's premier business thinkersC.K. Prahalad and M.S.
ICrishnanexplain, the internal management systems that feed external reporting
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The Advent of the International Financial Reporting Standards

can become an impediment. Building in flexibility, they say, is a prerequisite to
dealing with a world marked by constant change and innovation.2'' Despite the oneoff fixed costs in the tens of millions of dollars to implement IFRS, accountants
point out that the savings over time will dwarf the initial outlay, because the compliance costs of duplicate accounting, the bulk of which investors ultimately bear, will
disappear.28 it could even mean greater profits for firms. A recent study by Jack T.
Ciesielsld in The Ar\alyst's Accounting Observer found that among the 137 companies reporting 2006 results under both GAAP and IFRS, 63 percent showed higher
earnings with the international standards in place and for the median company,
profits jumped by 11 percent.29 Investors will also have reason to rejoice, as the new
standards make company financiis easier to compare, enabling them to invest internationally with more lcnowledge and confidence.^o Like investors, auditors will
appreciate the switch as it grants them greater room for judgment and interpretation.3i
Transitioning to IFRS is likely to impact the way in which management communicates with investors and companies conduct business with customers and vendors,
as well as the key processes of daily operations. These modifications may further
change employee responsibilities. Because IFRS conversions will also require the
retroactive restatement of certain historical periods and alter the baseline for each of
many key performance indicators, many of the metrics used by investors and
analysts to assess and compare companies are likely to change.32 In addition to
differences in bottom-line results, earnings volatility may vary when reporting under
IFRS. As more companies consolidate their businesses under the new financial
reporting requirements, they may need to renegotiate financing agreements, adjust
debt covenants and reconsider the implications for other long-term contracts such as
leases and derivative arrangements.^^ Internal operations may need to change as well
as companies begin to integrate the new reporting scheme throughout their businesses. Control over processes and information may need to be revisited, new
treasury and cash management strategies devised and information technology
systems upgraded.
Another important internal factor for most companies is taxes, which IFRS may
impact in terms of the amount of taxes paid and the effective tax rate. Because
various aspects of corporate culture have long conformed to GAAP, businesses may
need to modify compensation structures and appropriately train their worldorce
under IFRS. Despite the potential burden and expense of all of these changes^as
several multinational Fortune 50 companies have already discoveredtransitionrelated changes have the potential to deliver future dividends, such as streamlined
operations and reduced costs.34 With this longer-term outlook, instead of viewing
the changes as part of a compliance exercise, companies can strategically approach

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Julia Kotlyar

their conversion efforts and embed them into their operations.35

Given that almost worldwide acceptance of the IASB's principles-based rules is
due within the next decade, accountants are now debating the goals of the profession; should accounting be a driver for economic behavior or the point-in-time
reflection of a company's performance? Increased global mobility, transparency and
complexity, as reflected through business, dictates a change in the role of the
accountant. Sir David Tweedie, head of the IASB and perhaps the world's most
important accountant, says, "The accountant is an artist, but he has to portray his
subject faithfully I don't believe the accounting profession should have to endure the
25,000 pages of U.S. GAAP where judgment is replaced by a search engine."36
However, with accountants' judgments come differences in interpretation that
run counter to the comparability achieved through global IFRS implementation. The
mass global differences in definition and interpretation of a consolidated accounting
system will have to allow for diverse cultural interpretations causing enforcement of
the international rules to vary by country and thus potentially reducing a main
advantage of IFRS. It is already estimated that twenty-nine countries that use IFRS
have added their own exceptions to the rules, defeating the purpose of a global standard.37
While mass resistance to change is prevalent in global finance, countries like the
United States should promote the global implementation of IFRS as an opportunity
to streamline, standardize and ease reporting for companies as well as improve regulatory frameworlcs. If the global implementation of IFRS is used as a vehicle of
change, the many advantages of IFRS to investors will dwarf any minor discrepancies with the local standards based on differences in interpretation. The real goal of
the United States should not be to retain financial dominance or seek a postAmerican order in global finance, but instead should be the creation and
maintenance of a coalition of equals based on a sense of responsibility and stability
that promotes global economic growth and prosperity for all. Successful global
implementation of IFRS has the power to transform global finance by reinvigorating
and realigning the relations between business and society Rather than fearing an
absolute decline in its power and influence, the United States should instead adjust
to the rise of the rest of the world and lead by example. Thus, IFRS adoption will
not only make the United States more competitive in the world economy, but it will
also function as the beginning of a new chapter in global finance through better regulatory and legal frameworlcs in this post-American world. '^

NOTES
' Fareed Zakaria, The Post-American WbrW (London: W.W Norton & Company, 2008), 41; "The Global
Competitiveness Index 2007-2008," World Economic Forum, http://www.gcr.weforum.org.
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The Advent ofthe International Financial Reporting Standards

2 Fareed Zakaria, "The Future of American Power." Foreign Affairs 85, no. 3 (May/June 2008).
3 Richard Haas, "The Age of Nonpolarity." Foreign Affairs 85, no. 3 (May/June 2008).
4 Sarah Johnson, "IFRS: No Longer if, but When," CFO Magazine, 8 February 2008,
http://www.cfo.eom/article.cfm/l 0673513/l/c_2984368.
Floyd Nords, "US Moves Toward International Accounting Rules," New York Times, 27 August 2008,
http://\vww.nytimes.com/2008/08/28/business/worldbusiness/28audit.html?_r= 1 Siscp= 1 &sq=US%20M
oves%20Toward%20International%20Accounting%20Rules&st=cse&.oref=slogin.
6 Ibid.
7 Ibid.
8 "Accounting Standards: Closing the GAAP," Economist, 28 August 2008, http://www. ecbnomist.conV
finance/displaystorycfm?story_id= 12010009.
9 Floyd Norris, "SEC Takes Step Toward Global Accounting Rules," New York Times, 15 November
2007, http://www.nytimes.eom/2007/l l/15/business/16cndSEC.html?scp = 5Stsq = IFRS%20november%202007SiSt=cse.
"^ A.E. Feldman Associates, "SEG Steps Towards Gonvergence, Demand for IFRS Expertise to Grow,"
http://blog.aefeldman.eom/2007/l 1/20/sec-steps-towards-convergence-demand-for-ifrs-expertise-to-grow.
11 Tammy Whitehouse, "Are Investors Ready for Both IFRS and GAAP?" Compliance Week, 6
November 2007, http://www.complianceweek.com/index.cfm?fuseaction = article.viewArticleSiarticle
_ID=378O.
12 Selim Elekdag and Subir Lall, "Global Growth Estimates Trimmed After PPP Revisions," IMF Survey
Magazine, 8 January 2008.
13 Zakaria {2008b).
14 Ibid.
15 Alan Rappeport, "Deloitte Analyzes SEG's Take on IFRS," CFO Magazine, 31 January 2008,
http://www.cfo.com/article.cfm/10630273.
16 Harvey Goldschmid, "U.S. Gapital Markets' Gompetitiveness: Challenges and Ghoices," (speech,
Gouncil On Foreign Relations, New York, 15 May 2007), http://wvvw.cfr.org/publication/13340/
us_capital markets_competitiveness.html,
17 Zakaria (2008b).
18 Zakaria (2008a), 2.
19 "How We Develop Standards," International Standards Accounting Board, http://www.iasb.or^
About-f-Us/International-l-Accounting+Standards+Board+-+About+Us.htm.
20 Kennard S. Brackney and Philip R. Witner, "The European Union's Role in International Standards
Setting," CPA journal, November 2005, http://www.nysscpa.Org/cpajournal/2005/l 105/infocus/ p20.htm;
GIA World Fact Book: "World Economy," https://www.cia.gov/library/publications/the-world-factbook/
geos/xx.html#Econ.
21 Ibid.
22 "IFRS Resources," American Institute of Gertified Public Accountants, http://www.ifrs.conVupdates/
aicpa/ifrs_faq.html#q 1.

FALL/WINTER 2008 I 237

Julia Kotlyar
23 Richard Meyer, "IFRS Adoption: The China Experience," Compliance Week, 3 September 2008,
http://www,complianceweek,com/index,cfm?fuseaction=article,viewArticle&article_ID=4481,
24 "WXO Successfully Concludes Negotiations On China's Entry," (press release. World Trade
Organization, 17 February 2001) http://www,wto,org/english/news_e/pres01 e/pr243_e,htm,
25 Meyer,
26 "Accounting Standards: Closing the GAAP," Economist, 28 August 2008,
27 Coimbatore K, Prahalad and M,S, Krishnan, The New Age of Innovation: Driving Co-Created Value
through Global Networks (McGraw-Hill Professional, 2008), 25,
28 "Accounting Standards: Closing the GAAP" Economist, 28 August 2008,
29 David Henry, "Global Accounting Rules: Simpler Yes, but Better?" BusinessWeek, 4 September 2008,
http://www,businessweek,com/magazine/content/08_37/b4099035440167,htm?chan=top+news_top-)-n
ews+index+-+temp_companies,
30 "Accounting Standards: Closing the GAAP," Economist, 28 August 2008,
31 Ibid,
32 "IFRS Readiness Series: IFRS and US GAAP similarities and differences," PricewaterhouseCoopers,
September 2008, http://www,pwc.com/extweb/pwcpublications,nsf/docid/598E9D7EDF5239A08525
74AB00659431,
33 Ibid,
34 Ibid,
35 "10 Minutes on Transitioning to IFRS," PricewaterhouseCoopers, September 2008,
http://www,pwc.com/extweb/pwcpublications,nsf/docid/79BCA6195F364A9E852574BA00476313/$file/
PwC_ 10Minutes_090308, pdf
36 David Tweedie, "Bean Counters of Market Drivers? The Role of The Reporting Accountant," (lecture,
ICAS Conference, 4 April 2008),

http://www,iasb,org/NR/rdonlyres/78AD72F4-E8A9-4EFl-B67C-

D8421 D6EAEC6/0/Sir_David_Tweedie_ICAS_talk_2008,pdf,
37 Henry (2008),

238 I JOURNAL OF INTERNATIONAL AFFAIRS